How do I drive income with my SMSF?
Income-producing investments for SMSF trustees to consider.
With the Reserve Bank of Australia’s cash rate now at 1.5 per cent (as of 3rd August 2016), it has become increasingly difficult for investors to find investments that produce a high level of income.
However, there are still a number of investment vehicles that provide income to investors. But it’s important for SMSF investors to understand the risk/reward relationship of these instruments to ensure they don’t take on too much risk for a low return.
Here is a range of income-producing investments for SMSF investors to consider. But remember, while some exposure to fixed interest investments is a feature of most well-diversified portfolios, too much allocation to this asset class could dent future investment performance given returns from fixed interest investments are relatively low, partly as a result of the low cash rate.
Real estate and infrastructure
Real estate and infrastructure provide investment opportunities for SMSFS looking for income. Direct property generates income in the form of rent, which is a reliable source of revenue for SMSFs. However, property is a relatively illiquid asset compared to other investments, which should be factored in by SMSF investors when determining asset allocation for the fund. In addition there are strict rules that apply to SMSFs when it comes to investing in property and it’s important to fully understand these before committing to a property purchase.
Infrastructure investments are also an option. These assets provide a reliable income stream that can be used to generate revenue to match the fund’s pension obligations.
While it can be expensive to invest directly in both property and infrastructure, an alternative would be to invest in managed funds that have exposure to these asset classes. That way investors receive the asset allocation they require, while also benefiting from access to professional managers to administer the investments.
Another way to generate income is to invest in shares that pay a dividend, which is a portion of profit returned to investors. Traditionally, bank stock and telcos listed on the Australian Securities Exchange have produced good dividend yields. This measure is an average of the prior 12-months dividends divided by the share price. Listed businesses generally announce a dividend twice a year, when the full and half year financial results are released.
According to Market Index, six of the top ten dividend yielding stocks as at 28 April this year were financial services stocks. But it’s important to remember that just because a company has paid a high dividend in the past, this does not guarantee it will pay a dividend in the future.
However, many dividends are ‘fully franked’ which means the company passes on its tax credits to investors, allowing them to reduce their tax bill, another element that makes investing in stocks that pay a dividend attractive.
Another option is to invest in bonds issued by corporations. Companies issue these debt securities for a variety of reasons – for growth purposes, or sometimes to fulfil a funding shortfall. Be careful investing in corporate bonds if the company appears to be in distress, unless you are comfortable taking on that risk.
Corporate bonds pay a coupon over the life of the instrument, but generally don’t generate any capital growth. Some can be bought and sold on markets, and you will generally receive the funds you invested in the instrument at the end of the term of the bond. Bonds are generally considered to be lower risk than an equity investment. In the event the business enters administration bondholders are ranked higher than equity holders in the capital structure. There are also hybrid bonds that have equity and debt features, but these are generally more risky –but also offer a higher potential return – than standard corporate bonds.
Term deposits are a very safe way of investing, but they usually only generate a small return compared to other investments such as shares and property. The more money you are prepared to invest in a term deposit, and the longer you are prepared to invest, the higher the rate of return.
But be aware that you may be able to achieve the same rate of return in a normal transaction account, without locking your money away for a period. It’s also worth noting that if you need to use the money before the end of the term it’s likely you will pay a fee, which will reduce your return. Nevertheless, term deposits are a low-risk way of investing and SMSFs often allocate some funds to them.